OREANDA-NEWS. The struggles of UK retailer BHS and the risk of "Brexit" indicate the broad range of threats faced by European speculative-grade non-food retailers, Fitch Ratings says. A challenging macroeconomic environment, disruptive competition and riskier capital structures have driven credit profiles in the sector to their weakest level since 2010, as reflected in accelerated downward rating migration over the past year.

Nearly 60% of Fitch's publicly and privately rated European non-food retailers (including credit opinions) have been downgraded or put on Negative Outlook over the last 12 months. The total "at-risk" share of the portfolio ('B-'/Negative or lower) has risen to nearly 70% from 55%, the most since the post-crisis high in 2010.

The combination of subdued economic growth, uneven consumer confidence across the EU, high unemployment and persistently high competition have all put pressure on credit quality. But negative rating actions for issuers with legacy debt structures have also been prompted by their inability to adapt business models to disruptive sector trends. The rise of pure online retailers with scale and financial strength is forcing conventional retailers into costly investment in technology and distribution platforms. This is particularly challenging for mid-cap retailers in the highly speculative rating range, due to their generally limited size, inherently high vulnerability and lower financial flexibility.

Liquidity shortages are also hitting retailers trying to balance multi-channel distribution investment and logistics against shrinking margins and working-capital swings due to stock clearances and product mix revamps. This has contributed to the decline of BHS, which on Wednesday agreed with creditors and landlords to cut rents at some stores to try to turn the struggling business around. Next plc's prediction on Thursday that it faces a difficult 2016 shows that even retailers that have successfully adapted their business models are finding it hard to maintain sales growth and profitability.

"Brexit" would compound the tough outlook for UK-based leveraged retailers, which could come under pressure from macroeconomic uncertainties, particularly if exit negotiations were protracted and acrimonious. Smaller companies with weaker commercial profiles and those with a larger exposure to the EU would be most at risk. But the impact on continental European non-food retailers would probably be minimal, as most only operate in their home markets or in other eurozone countries.

Other recent downgrades have been of companies with sustainable business models but riskier capital structures following refinancings and recapitalisations in debtor-friendly credit markets. The combination of aggressively funded balance sheets with unchanged commercial profiles and low organic growth prospects make de-leveraging difficult, signalling persistently high credit risk in the medium term.

Such credits will typically face less rating pressure in the near term, provided they maintain the integrity of organic cash generation, with refinancing risks deferred, as for Financiere IKKS and New Look (both rated 'B-'/Stable). But it does make the ability to manage operational risks particularly important in our analysis, as heavily debt-laden corporates are more susceptible to external risks and have less leeway for commercial miscalculations.